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Research Firms,
Consultants
Draw Scrutiny

New York, SEC Examine
Information Disclosures
To Hedge Funds, Others

By

Gregory Zuckerman and

Peter Lattman

Updated Jan. 16, 2007 12:01 a.m. ET

A lucrative corner of the financial-services industry -- involving research firms like Gerson Lehrman Group that pay employees of public companies and others to serve as consultants to investors -- is coming under scrutiny by regulators.

In recent weeks, the New York Attorney General's office has begun examining whether employees of companies including
Best Buy Co.
may have inappropriately discussed material nonpublic information in consulting arrangements like these with hedge funds and other investors. The examination also concerns
Circuit City Stores Inc.,
according to one person briefed on the matter.

According to people close to the situation, the office is looking into whether consultants paid by Gerson Lehrman and another major provider of this kind of service, Vista Research, may have inappropriately disclosed important information about the companies in which they work. Securities rules prohibit trading on material nonpublic information -- the term for potentially market-moving business details not otherwise available to the investing public.

Wall Street Journal Video

WSJ.com's Peter Lattman and former federal prosecutor Solomon Wisenberg discuss research firms that pay employees of public companies and others to serve as consultants to investors.

The New York Attorney General's office has issued subpoenas recently to Gerson and Vista, a unit of McGraw-Hill Cos., as well as to hedge funds that are clients of Gerson and Vista.

A Vista spokesman said by email that "Vista Research is fully cooperating with the NYSAG's subpoena. Vista Research is committed to strong compliance practices and procedures."

A spokeswoman for Best Buy said the company has been contacted by the New York Attorney General's office "and we are cooperating with the investigation." Circuit City didn't respond to a request for comment.

Separately, the Securities and Exchange Commission is working on several investigations to see if hedge funds have received nonpublic information due to research firms like these. The SEC has sent requests for information to a number of hedge funds, according to an individual familiar with the situation. The inquiries come amid a broader push by securities regulators to examine whether hedge funds -- which have emerged as influential players in the financial markets -- are using nonpublic information to gain a trading edge. Hedge funds are private partnerships catering to wealthy investors that trade a range of investments.

Gerson and Vista match consultants -- professors and lawyers as well as current and former managers at companies -- with hedge funds and other investors interested in certain industries.

Regulators are focusing on whether consultants who are or were employed by public companies have shared nonpublic information with the investors they talk to, either knowingly or unintentionally.

The subpoenas are broad in nature, according to two people who have seen them. A spokesman for the New York Attorney General's office declined to comment.

Some subpoenas were issued at the end of December, when
Eliot Spitzer
was still New York's attorney general. On Jan. 1, Mr. Spitzer became the state's governor, and Andrew Cuomo became its attorney general.

In recent years, firms that match large investors with stables of consultants have seen their businesses grow, both because there are more hedge funds eager for these insights and because regulatory changes have barred companies from selectively disclosing important nonpublic information.

In the information-broker business since 1999, Gerson charges top dollar to match professional investors with its stable of 180,000 consultants. The consultants, who often are paid hourly to speak with investors, include current and former middle managers from hundreds of companies as well as doctors and other professionals. The vast majority don't work for public companies.

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Vista, founded in 2001, says on its Web site it has 100,000 consultants. The firm was acquired in 2005 by Standard & Poor's, a division of McGraw-Hill Cos. There is nothing inherently improper about matching investors with people familiar with companies and industries, nor is there anything wrong with investors' speaking with industry managers to understand trends in a business or receive views about competitors or products.

Investors and Wall Street analysts have long done in-depth research by speaking with various employees. But regulators want to know if consultants paid by Gerson and Vista are passing along material nonpublic information about companies.

In a page-one article on Gerson, The Wall Street Journal reported in November that Gerson consultants employed by public companies sometimes are unaware of their own companies' restrictions or have a hazy understanding of what qualifies as nonpublic information.

Gerson and Vista take steps to prevent their consultants from sharing inappropriate information. Gerson has said all of its consultants must agree in writing each year to follow the rules of their primary employers. The firm also has said it constantly reminds consultants and clients not to discuss confidential or restricted information and advises them on how to learn if their employer has rules governing this consulting.

A consultant can't speak with an investor client more than three times a year unless the employee receives permission from his employer to moonlight, or is independent.

A Vista spokesman says each of its consultants has to sign a form periodically to affirm that they are in compliance with Vista's code of ethics. The code of ethics says its consultants are "never expected" to comment on their employer or company. It also says its consultants may not disclose any confidential, proprietary or trade-secret information of others.

The Journal's story in November about Gerson said its consultants sometimes don't inform their employers when they are being paid to speak with a hedge fund or other investor. And they sometimes consult with investors in violation of their employers' policies.

The emergence of companies like Vista and Gerson coincided with a change in company disclosure rules in 2000. That year the SEC instituted Regulation Fair Disclosure, or Reg FD, which barred companies from selectively disclosing material nonpublic information. Prior to Reg FD, employees spoke more freely with professional investors and analysts about their businesses.